Economics, Politics, and Ethics for the Ursuline Girl

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Perverse Incentives: Self-interest Makes the World Go Around

An incentive is a force that motivates or encourages an individual to do something. When individuals have the opportunity to gain a reward due to something they do, they have the incentive to get reach this goal, no matter what. This comes from the economic understanding of human behavior that people will do whatever it takes to make themselves better off. This assumption demonstrates that the use of incentives to manipulate people in a market can either have positive or negative outcomes. “…Unfettered self-interest leads to poor outcomes” [1] because people do not always know what is in their best interest and will do whatever they believe at the time will maximize their utility. Economics relies on the fact that people, whether informed of the consequences or not, will act on self-interest; therefore, markets must learn to use this human understanding to their advantage in order to maximize the actual good utility.

For example, a provision of the Endangered Species Act states that if any part of land is reported by someone to be considered a good habitat for an endangered species, then it will be declared off-limits to all expansion in that area. Unfortunately, this caused the already scarce land that would have been good habitats to be destroyed. This was due to the understanding that the market value of the land would be lowered due to this provision, so landowners took matters into their own hands and clear-cut their entire properties. As a result, there was an immense decrease in the amount of land that would be suitable for any endangered species [2]. This is known as a perverse incentive, when unintended consequences result from an attempt to do something completely different. Perverse incentives can also arise when governments interfere with markets and mess with prices. “The market ‘fails’ [when] it encourages individuals to cut corners in ways that make society worse off as a result.” [1].

“Economics teaches us how to get incentives right” [1]. If we know people will always act according to their own self-interest, than we can use that to form incentives that align with the good of society. In the case of the endangered species, a way to keep people from acting selfishly by destroying the habitats would be for the government to pay them in order to use their land as a sanctuary for the animals. Since we know that the land owners will act in their own self-interest, the money offered to them would have to be larger than the land is worth to them. The incentive of the land owners to get rich, although seemingly selfish, will in turn help the good of society because the land will be preserved in the end. Therefore, when we can begin to understand and predict the way humans will act, we can improve the economy and quality of life because we will be prepared to adjust to the consistency of people acting on self-interest.